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Highway Repairs Are Domestic Production Property

The
Tax Court held that a taxpayer’s receipts from highway construction
projects were domestic production gross receipts (DPGR) permitting
the taxpayer to claim a domestic production activities deduction.
The court held that the taxpayer’s work substantially renovated real
property, since it materially increased the property’s value,
substantially prolonged its useful life or adapted the property to a
new use.

IRC
§ 199 permits taxpayers with DPGR to take a deduction equal to
9% (3% in 2005 and 2006 and 6% in 2007 through 2009) of the lesser
of qualified production activities income or taxable income before
the deduction. DPGR includes receipts from the construction of real
property, defined as the erection or substantial renovation of
buildings, structural components and infrastructure, in the United
States. Treas.
Reg. § 1.199-3(m)(5) defines “substantial renovation” as “the
renovation of a major component or substantial structural part of
real property that materially increases the value of the property,
substantially prolongs the useful life of the property, or adapts
the property to a new or different use.”

Gibson
and Associates Inc., an engineering and heavy construction company
in Texas, builds or renovates infrastructure in Texas, Oklahoma,
Arkansas and Kansas. For the tax year ended June 30, 2006, Gibson
reported $26,053,570 of DPGR from 136 construction projects,
claiming a domestic production activities deduction of $63,435. The
IRS disallowed the entire deduction, claiming Gibson had no DPGR for
the tax year. Gibson petitioned the Tax Court where, after
concessions by both sides, nearly $12 million of the DPGR originally
reported by Gibson remained in dispute.

Both
parties presented expert witnesses to argue for or against the
taxpayer’s contention that the disputed projects substantially
renovated the property. William E. Gibson, the company CEO and a
licensed engineer with 40 years of experience in the highway and
bridge construction business, testified that the work increased the
useful lives of some property by at least three years, increased the
value of other property by at least 5% and adapted other property to
a new use.

The
court held that the substantial renovation standard had to be
applied to each building, bridge or other permanent structure that
Gibson worked on during the tax year. It then accepted the
taxpayer’s argument that one project adapted that property to a new
or different use, since after the work was performed, the property
became accessible to people covered by the Americans with
Disabilities Act. The court also held that 18 other projects that
repaired damaged infrastructure substantially renovated those
properties. These properties had been damaged by casualties
rendering them completely or partially inoperative, and the court
held that Gibson’s work increased their values and functionality by
permitting them to function as originally intended.

The
court also reviewed 80 other projects involving property (mostly
bridges) that was not functioning as originally intended due to lack
of proper maintenance. The court agreed with Gibson that its
renovation of major structural components increased the useful life
of these properties by more than three years. The court also
rejected the IRS’ contention that the rehabilitation of one or more
components of a property is a repair unless all of the major
components were replaced.

The results of the 2016 presidential election are likely to have a big impact on federal tax policy in the coming years. Eddie Adkins, CPA, a partner in the Washington National Tax Office at Grant Thornton, discusses what parts of the ACA might survive the repeal of most of the law.